Uses and Limitations of Marginal Costing

Managerial Uses of Marginal Costing:

(a) Cost Ascertainment:

Marginal costing technique facilitates not only the recording of costs but their reporting also. The classification of costs into fixed and variable components makes the job of cost ascertainment easier. The main problem in this regard is only the segregation of the semi-variable cost into fixed and variable elements. However, this may be overcome by adopting any of the methods in this regard.

(b) Cost Control:

Marginal cost statements can be understood easily by the management than those presented under absorption costing. Bifurcation of costs into fixed and variable enables management to exercise control over production cost and thereby affect efficiency.

In fact, while variable costs are controllable at the lower levels of management, fixed costs can be controlled at the top level. Under this technique, management can study the behaviour of costs at varying conditions of output and sales and thereby exercise better control over costs.

(c) Decision-Making:

Modern management is faced with a number of decision-making problems every day. Profitability is the main criterion for selecting the best course of action. Marginal costing through ‘contribution’ assists management in solving problems.

Some of the decision-making problems that can be solved by marginal costing are:

(a) Profit planning

(b) Pricing of products

(c) Make or buy decisions

(d) Product mix etc.

Limitations of Marginal Costing:

(a) Segregation of all costs into fixed and variable costs is very difficult. In practice, a major technical difficulty arises in drawing a sharp line of demarcation between fixed and variable costs. The distinction between them hold good only in the short run. In the long run, however, all costs are variable.

(b) In marginal costing, greater importance is attached to the sales function thereby relegating the production function largely to a secondary position. But, the real efficiency of a business is to be assessed only by considering the selling and production functions together.

(c) The elimination of fixed costs from the valuation of inventories is illogical since costs are also incurred in the manufacture of goods. Further, it results in the understatement of the value of stock, which is neither the cost nor the market price.

(d) Pricing decision cannot be based on contribution alone. Sometimes, the contribution will be unrealistic when increased production and sales are effected, either through extensive use of existing machinery or by replacing manual labour by machines. Another possibility is that there is danger of too many sales being affected at marginal cost, resulting in denial to the business of inadequate profits.

(e) Although the problem of over or under absorption of fixed overheads can be overcome to a certain extent, the same problems still persists with regard to variable overheads.

(f) The application of the technique is limited in the case of industries in which, according to the nature of business, large stocks have to be carried by way of work-in-progress (e.g. contracting firms).